Learning Material Sample
Pension income options1. The main retirement rulesLearning outcome: Understand the rules that apply to retirement benefits when they are crystallised
Pension simplification came into force on 6 April 2006, kn...
Shortened demo course. See details at foot of page. ...schemes or stakeholder pensions covered in other chapters. The lifetime allowance (LTA) was a limit on the overall value of pension savings that could be taken without incurring an additional tax charge, including benefits that built up prior to 6 April 2006 (A-Day).
The LTA was set by the Treasury and, since it was introduced in 2006, the figures were as follows: 2006/07 - £1.5 million 2007/08 - £1.6 million 2008/09 - £1.65 million 2009/10 - £1.75 million 2010/11 - £1.8 million 2011/12 - £1.8 million 2012/13 - £1.5 million 2013/14 - £1.5 million 2014/15 - £1.25 million 2015/16 - £1.25 million 2016/17 - £1.0 million 2017/18 - £1.0 million 2018/19 - £1.03 million 2019/20 - £1.055m 2020/21 - £1,0731m 2021/22 - £1,0731m 2022/23 - £1,0731m 2023/24 - £1,0731m With effect from the start of the 2024/25 tax year, the lifetime allowance was formally abolished. However, it will still be relevant for the purposes of determining the member’s entitlement to tax-free lump sums during their lifetime, or that of their beneficiaries in the event of their death before the age of 75. Fixed protection When reducing the LTA to £1.5 million in 2012, the Government recognised that there should be a ‘protection regime’ for those who had already made pension saving decisions based on an LTA £1.8 million. This protection was designed to cover those with savings above £1.5 million or who believed the value of their pension pot would rise to above that level through investment growth without any further contributions or pension savings and who did not already have primary or enhanced protection. They were able to apply for ‘fixed protection’, i.e. a personalised LTA of £1.8 million, providing there was no benefit accrual in any registered pension scheme after 5 April 2012. Any excess value above £1.8 million would be subject to a LTA tax charge. This did mean, though, they could take a tax-free PCLS of up to 25% of £1.8 million. Under defined contribution schemes, benefit accrual occurred if any further relevant contributions were made after 5 April 2012. The only contributions allowed were contributions to provide life cover, which was in place before 6 April 2006. Under defined benefit schemes it meant that the benefit value (i.e. 20 times the accrued pension plus any separate PCLS) could not increase by more than the relevant percentage in any tax year after 5 April 2012. The relevant percentage was any annual rate of benefit increase specified in the scheme rules on 9 December 2010 or, if no increases are specified, the increase in the Consumer Prices Index (CPI) for the year to the September before the start of the tax year. Benefit accrual under fixed protection was tested every year, unlike under enhanced protection where it was tested only on transfer or on crystallising benefits. Scheme members who had fixed protection and are automatically enrolled into a qualifying pension scheme under auto-enrolment originally had to opt out within one month of their auto-enrolment date or they would have lost their fixed protection. Since 1 April 2015 employers were allowed to exempt workers from the auto-enrolment requiremen... Shortened demo course. See details at foot of page. ...declaration to be in a flexible drawdown pensionFlexi-access drawdown Previously a flexible drawdown plan where the nomination was accepted in a drawdown year starting on or after 27 March 2014 25 × 80% the maximum permitted income that could be paid if the contract was a capped drawdown at the date of the BCE Flexi-access drawdown Capped drawdown – converted to flexi-access drawdown on or after 6 April 2015 25 × 80% of the maximum permitted income from a capped drawdown pension that could have been paid when the member’s drawdown pension fund became a flexi-access drawdown fund Testing against the lifetime allowance Whenever a BCE took place after A-Day the value of the new benefits being crystallised was tested against the member’s available LTA and used up a percentage of that allowance. The remaining percentage was then carried forward for use at the member’s next BCE. Example Rashid crystallised excess benefits valued at £200,000. If he took this chargeable amount as a lump sum, it would suffer tax of £110,000 (i.e. 55% x £200,000), leaving a lump sum payment of £90,000. If he decided to use the chargeable amount to provide pension income, it would suffer tax of £50,000 (i.e. 25% x £200,000). The pension income provided by the remaining £150,000 would also suffer income tax at his marginal rate of income tax. From 6 April 2024, the lifetime allowance excess charge ceased to exist, to be replaced by the lump sum allowance and the lump sum and death benefits allowance. Lifetime allowance charge The LTA charge was a tax charge that applied at any BCE where the crystallised value of the new benefits exceeded the member’s available LTA. The tax charge applied to the excess over the available allowance, known as the chargeable amount. The charge was designed to recoup the tax breaks the member had received on the excess funds over the years they had been sheltered inside the pension tax regime. Prior to 6 April 2023, the amount of tax charged depended on the form in which the excess benefits were paid: If the excess was paid as a lump sum, it was taxed at 55% If the excess was used to provide pension income, it was taxed at 25%. Remember, the pension provided by the remaining 75% was also subject to income tax at the member’s marginal rate of income tax Example Rashid crystallises excess benefits valued at £200,000. If he takes this chargeable amount as a lump sum, it will suffer tax of £110,000 (i.e. 55% x £200,000), leaving a lump sum payment of £90,000. If he decides to use the chargeable amount to provide pension income, it will suffer tax of £50,000 (i.e. 25% x £200,000). The pension income provided by the remaining £150,000 will also suffer income tax at his marginal rate of income tax. Since 6 April 2023, the rate of the charge has been 0%. Technically, it still exists, however, in effect, no tax is paid. Instead, lifetime allowance excess benefits will simply be subject to income tax under PAYE on the recipient. From 6 April 2024, the lifetime allowance excess charge will formally cease to exist. What tax rates were used to calculate the LTA charge? Answer : Purchase course for answer This section covers the money purchase annual allowance and the annual allowance charge.
The annual allowance is a limit on the value of ‘pension input amount’ that qualifies for tax relief during each ‘pension input period’. If the amount of pension input is more than the available annual allowance, an annual allowance charge is paid, charged at the individual’s marginal rate(s) of income tax. The annual allowance for 2024/25 is £60,000. Prior to the 2023/24 tax year, it had been £40,000 for several years. The increase was announced during the spring budget 2023. However this is tapered (reduced by £1 for every £2) for those people with ‘threshold income’ over £200,000 and ‘adjusted income’ over £260,000. Threshold income is gross taxable income (investment as well as earned): Less the grossed-up amount of any pension contribution (made by anyone other than their employer), subject to relief at source or net pay Plus any employment income given up via salary sacrifice via an arrangement set-up on or after 9 July 2015 Less any lump sum death benefits taxed as income If this is greater than £200,000 then adjusted income must be calculated. (If someone has threshold income of £200,000 or less will not be subject to the taper and there is no need to calculate adjusted income). Adjusted income is gross taxable income: Plus any employer contributions Less any lump sum death benefits taxed as income If this is greater than £260,000 the annual allowance is tapered, if less or equal to £260,000 no tapering is needed. As a result of the new pension flexibilities, the money purchase annual allowance (MPAA) was introduced. The MPAA rules work with the annual allowance rules to make sure that the new flexibilities cannot be abused. The MPAA has been £10,000 since April 2023. Previously, it was £10,000 from April 2015... Shortened demo course. See details at foot of page. ...lowance of £60,000.This leaves £40,000 to be carried forward from the previous 3 years, starting with the earliest year. £15,000 is carried forward from 2021/22. £10,000 is carried forward from 2022/23. He then carries forward £15,000 from 2023/24 which means there is £25,000 to be used in 2025/26 or 2026/27. The annual allowance charge The annual allowance charge is a tax charge that applies when an individual’s pension input amount for a tax year exceeds that year’s annual allowance/MPAA. The tax charge is usually levied on the member at their marginal rate of tax. This means that the excess over the annual allowance would be charged at more than one income tax rate if it falls into more than one income tax band. The excess over the annual allowance/MPAA is added to the person’s taxable income (the amount after the personal allowance has been deducted). The annual allowance charge is collected from the individual via their self-assessment tax return. Individuals with an annual allowance charge of over £2,000 and whose pension savings exceeded the annual allowance (not just the MPAA) can elect for the scheme administrator to pay all or part of the annual allowance charge on their behalf. This is known as ‘scheme pays’ and will result in the member's pension benefits being reduced. In defined contribution schemes, the charge will be deducted from the fund and in defined benefit schemes, an adjustment will be made to the accrued benefits. All contributions paid to UK registered pension scheme count towards the annual allowance, whether they receive tax relief or not. Only contributions paid to non-registered pension schemes (e.g. employer-financed retirement benefits schemes), do not count. It is possible to carry forward any unused annual allowance to the current tax year from how many of the previous tax years? Answer : Purchase course for answer Following the abolition of the lifetime allowance, it was decided to retain the limit on the amount of tax-free lump sums which can be taken by a member from a registered pension scheme. This is known as the lump sum allowance (LSA). It is designed to ensure that tax-free lump sum entitlements continue to work in broadly the same manner as under the lifetime allowance system, despite the abolition of the LTA excess tax charge itself.
The standard lump sum allowance for 2024/25 is £268,275, which is 25% of the previous standard lifetime allowance of £1,073,100. There is currently no provision in legislation to increase this in future years. Scheme members who benefitted from transitional lifetime allowance protection can keep a lump sum allowance. The treatment of this is as follows:
Form of protection Lump sum allowance Enhanced protection (no lump sum protection) £375,000 Enhanced protection (with lump sum protection) Dependent on value of protected entitlement Primary protection (no lump sum protection) £375,000 Primary protection (with lump sum protection) Dependent on primary protection factor. Fixed protection 2012 £450,000 Fixed protection 2014 £375,000 Fixed protection 2016 £312,500 Individual protection 2014 25% of individually protected amount between £1.25m and £1.5m Individual protection 2016 25% of individually protected amount between £1m and £1.25m An event tested against the lump sum allowance is known as a relevant benefit crystallisation event (RBCE). These are not to be confused with the BCEs tested against the old lifetime allowance. This occurs when the member becomes entitled to a relevant lump sum. The following benefits are relevant lump sums and are tested against the LSA: Pension commencement lump sum (PCLS) Stand-alone lump sum (SALS) Uncrystallised funds pension lump sum (UFPLS) non-taxable part The following are not RBCEs Small pots payments Trivial commutation lump sums Winding up lump sums The lump sum allowance will normally be calculated under the standard transitional calculation. This includes a deduction for any benefits taken prior to its introduction. The calculation deducts 25% of any lifetime allowance which was used prior to 6 April 2024. Peter holds individual protection 2014 with a protected amount of £1,375,000. What is his lump sum allowance?
Answer : Purchase course for answer The lump sum and death benefits allowance operates along a similar line to the lump sum allowance. It is a limited on the total amount of tax-free lump sum payments which can be taken from registered pension schemes during the member’s lifetime and in the event of their death before the age of 75. It therefore differs from the lump sum allowance, which is lower and relates to lump sums taken solely during the member’s lifetime.
The lump sum and death benefits allowance will be broadly equal to the member’s previous lifetime allowance. Therefore, for anyone without previous LTA protection, the allowance will be £1,073,100. Those with a protected lifetime allowance will benefit from a protected lump sum and death benefits allowance which is in line with their previous protected allowance. For those with enhanced protection, the allowance will be the value of their uncrystallised funds as of 5 April 2024. The following relevant lump-sum death benefits are tested against the LSDBA: Defined benefits lump sum death benefit Uncrystallised funds lump sum death benefit Annuity protection lump sum death benefit Pension protection lump sum death benefit Drawdown/flexi-access drawdown lump sum death benefit Dependents/nominees/successors flexi-access drawdown lump sum death benefit The following relevant lump-sum death benefits are NOT tested against LSDBA: Charity lump sum death benefit Trivial commutation lump sum death benefit Type of lump sum Tested against LSA Tested against LSDBA Pension commencement lump sum (PCLS) Yes No Stand-alone lump sum (SALS) Yes No Uncrystallised Funds Pension Lump Sum (UFPLS) Yes No Serious ill-health lump sum (SIHLS) Yes No Small pots lump sum No No Trivial commutation lump sum No No Winding-up lump sum No No Defined benefits lump sum death benefit No Yes Uncrystallised funds lump sum death benefit No Yes Annuity protection lump sum death benefit No Yes Pension protection lump sum death benefit No Yes Drawdown/flexi-access drawdown lump sum death benefit No Yes Dependents/nominees/successors flexi-access drawdown lump sum death benefit. No Yes Charity lump sum death benefit No No Trivial commutation lump sum death benefit No No Scheme members also have an Overseas Transfer Allowance (OTA). This limits the amount which can be transferred to a Qualifying Recognised Overseas Pension Scheme (QROPS). The limit is equivalent to the member’s previous lifetime allowance, with any excess subject to a flat 25% tax charge. Name two lump sum death benefits which will not be tested against the LSDBA.
Answer : Purchase course for answer The standard transitional calculation for both the LSA and the LSDBA deducts 25% of the lifetime allowance previously used.
Example Omar crystallised £500,000, taking £125,000 PCLS and placing the balance into drawdown in 2017 when the lifetime allowance was £1.25m. He did not apply for lifetime allowance protection. His LTA use was £500,000/£1.25m = 40% His lump sum allowance would be £268,275 – (£1,073,100 x 40% x 25%) = £268,275 - £107,310 = £160,965 His lump sum and death benefits allowance would be £1,073,100 less the same, i.e. £965,790. This may cause an issue in certain circumstances. The standard calculation assumes that the member took 25% tax-free cash at each BCE. In practice, this may not turn out to have been the case. Some of the circumstances in which they may not have done include the following: No PCLS was taken due to a poor commutation rate PCLS restricted by GMP element DB scheme with defined PCLS rates e.g. 3/80ths D... Shortened demo course. See details at foot of page. ...– (£1,073,100 x 37.27% x 25%= £268,275 - £99,986 = £168,289 Note: the figure of £99,986 rather than £100,000 is due to rounding error as LTA use is rounded down to two decimal places. The same figure would be used as the basis for her lump sum and death benefits allowance, i.e. £1,073,100 - £99,986. Example Prith took a scheme pension of £30,000 per annum and £200,000 lump sum in 2013 when the lifetime allowance was £1.5m. He has not applied for any lifetime allowance protection. He therefore used 53.33% of the LTA His standard transitional lump sum amount would be: £268,275 – (£1,073,100 x 53.33% x 25%) = £268,275 - £143,071 = £125,204 However, if he applied for a TTFAC then his amount would be £268,275 - £200,000, or £68,275. He would therefore be disadvantaged as a result. State five categories of scheme member who may benefit from applying for a TTFAC. Answer : Purchase course for answer There is no longer a statutory concept of a normal retirement age. Retirement can now take place at any time after the normal minimum pension age (NMPA) which is currently age 55. Of course, employers may still choose to set a standard retirement age under their pension scheme but cannot force an employee to retire at that age.
There are two exceptions to the NMPA: Where deferred or current members of occupational or statutory schemes already had a contractual right to retire at age 50. This right must have existed on 10 December 2003 and must have been genuinely contractual, i.e. ... Shortened demo course. See details at foot of page. ... where the scheme rules included, prior to 11 February 2021, an unqualified right to take benefits before the age of 57 and the member joined the scheme before 4 November 2021, the right to the lower pension age will remain.The new normal minimum pension age will not apply to public service schemes – the police, armed forces, firefighters, etc – they will not have an NMPA that is linked to State pension age. By how much will the LSA and LSDBA be reduced where a scheme member takes benefits early on the grounds of ill-health?
Answer : Purchase course for answer Benefits can be taken from a defined contribution scheme in the form of an income and/or as a lump sum. The benefits depend on the size of the fund that has been built up. Pension commencement lump sum (PCLS) A PCLS is usually available except when there is no scope in the scheme rules for any of the proceeds to be paid out as a lump sum (which would be rare) or where the member has used up all of their PCLS allowance. The maximum PCLS is generally 25% of the fund, subjec... Shortened demo course. See details at foot of page. ...n of buying an annuity.It is an FCA requirement that providers of individual pensions give members the opportunity to choose the insurer which is to provide their lifetime annuity. This is known as taking an open market option (OMO), i.e. buying an annuity from any authorised insurer. This requirement does not extend to occupational schemes but would generally be regarded as good practice. Members of what types of schemes must be offered an OMO? Answer : Purchase course for answer Pension at normal retirement age
As stated earlier the level of benefits that a member receives at normal retirement age depends on the following factors: Scheme accrual rate Pensionable service Pensionable remuneration The interaction of these factors will determine the ... Shortened demo course. See details at foot of page. ... a PCLS is provided by commutation, the Pensions Tax manual lays out a formula; where the maximum PCLS of 25% of the value of the pension benefits is taken, the formula is:PCLS = [20 x pre-commutation pension x C]/[20 + (3 x C)] where C is the commutation factor used by the scheme. All registered pension schemes can pay up to 25% of the value of the benefits (subject to the LSA) as a pension commencement lump sum (PCLS) w...
Shortened demo course. See details at foot of page. ...-access drawdownUncrystallised funds pension lump sum (UFPLS) - these are lump sum payments paid directly out of uncrystallised funds Once a lifetime annuity or scheme pension is in payment there are three types of death benefit available, depending on the options selected at outset:
Guarantee periods: Scheme pension payments may be guaranteed for a period of up to ten years, regardless of the member’s age. For a lifetime annuity, the time limit on a guarantee period was removed from 6 April 2015 and will be at the annuity provider’s discretion. Prior to 6 April 2015, such payments from both scheme pensions and lifetime annuities were taxable for the recipient(s) and could not be commuted. Since 6 April 2015, any income received by a beneficiary under a lifetime annuity guarantee period will now be tax-free if the member died prior to age 75. Income received by a beneficiary from a scheme pension under a guarantee period, and income received by a beneficiary from a lifetime annuity under a guarantee period whe... Shortened demo course. See details at foot of page. ... no surviving dependants of the member. The pension scheme administrators are not allowed to do so.Such a lump sum is paid without any tax charge. There is also no tax charge on the charity receiving the payment if it is used for charitable purposes. Members are encouraged to complete an expression of wish form to advise the trustees who they wish benefits to be payable to on death but this is not binding on the trustees, who have full discretion as to who to pay the lump sum to. In most cases, however, the trustees will follow the member’s wishes. If the member does not complete an expression of wish form the trustees must investigate their domestic situation following death to search for dependent persons as defined by the scheme’s rules What are the death benefits available when a scheme member dies whilst in flexi-access drawdown? Answer : Purchase course for answer Trivial commutation and small pots
Where a member’s pension benefits are small they can be commuted for a trivial commutation lump sum or a small pots payment. Trivial commutation is available where the member is aged at least 55 (or has reached their protected pension age or they meet the ill-health conditions) and on a nominated date the value of their pension rights is not more than £30,000. When the rules changed in April 2015, a trivial commutation payment could only be in respect of a defin... Shortened demo course. See details at foot of page. ...member’s pension income under PAYE.To help simplify retirement rules, the Government reduced the age at which an individual could take a small pot from 60 to 55, with effect from 6 April 2015. It is also possible to take a small pot payment from an earlier age where the member either has a protected pension age or is suffering ill health and takes early retirement. Explain the conditions that must be met for a member to receive a trivial commutation lump sum. Answer : Purchase course for answer Ill-health benefits
Subject to certain transitional reliefs, drawing benefits before normal minimum pension age (55) is only possible on grounds of ill-health. The Finance Act 2004 defines an ‘ill-health condition’ which must be met for this to occur. The condition is that the scheme administrator has received evidence from a registered medical practitioner that the member is (and will continue to be) incapable of carrying on the member’s occupation because of physical or mental impairment, and the member has in fact ceased to carry on the member’s occupation. Although the rule implies a permanent condition, the legislation has evolved so that a scheme can suspend or reduce payment of an ill-health pension if the member regains their health. If the member has a life expectancy of less than one year, it is possible to commute their uncrystallised arrangements for a ‘serious ill-health lump sum’. The lump sum will be paid free of tax (subject to a lump sum and death benefits allowance test) unless the member is age 75 or over, in which case it is taxable as the recipient’s income via PAYE. Unless the scheme administrator obtains confirm... Shortened demo course. See details at foot of page. ...if the member has started to draw retirement benefits.Survivor's pensions are usually calculated as a percentage of the member’s pension in payment (e.g. 50%). For calculation purposes, the member’s pension is usually taken as the amount he/she would have received without commuting any of it for a pension commencement lump sum. There is no limit on the amount of survivor’s pension that can be drawn if the member dies before their 75 th birthday. If the member dies after age 75 in receipt of a scheme pension, then the survivor’s pension is restricted to 100% of the member’s pension in the year to death, plus 5% of any pension commencement lump sum drawn by the member. Many schemes allow an allocation option giving retiring members the chance to surrender part of their pensions to increase the potential survivor’s pension. The Finance Act 2004 defines an ‘ill-health condition’ which must be met for a defined benefit occupational scheme pension to become payable in the event of early retirement due to ill health. State the main elements of this condition that must be adhered to. Answer : Purchase course for answer When married couples get divorced any pension benefits can be included when dividing up assets.
Please note that we will call the person with pension benefits the member and the person claiming part of the member’s benefits on divorce the ex-spouse. For divorces after December 2000 there are three options. Offsetting Offsetting involves ordering the member to pay over a greater share of other non-pension assets than would otherwise have been the case if no pension rights had existed. Offset has the advantage of leaving pension benefits intact for the pension member, though the obvious disadvantage is that the ex-spouse has no pension provision for retirement. However, offset is still common in the divorce process, with one reason being that it allows a clean break. Example Tom and Joyce are divorcing. Their assets are a house worth £400,000, £210,000 in cash and other assets as well as Tom’s pension rights which have been valued at £320,000. Their total assets are therefore £930,000. If an offset arrangement is agreed, Tom could retain his pension fund plus £145,000 and Joyce should have the house plus £65,000. Defined benefit schemes To calculate the gross value of the member’s accrued benefits, the cash equivalent transfer value is used. When establishing the amount of ‘offset’ the following is taken into account: The ex-spouse will no longer be entitled to any pension and tax free cash once they are in payment They will not be entitled to a spouse’s pension if the member predeceases them They will lose any death in service benefits Defined contribution schemes The loss to the ex-spouse is worked out by agreeing a percentage or division of the fund taking into account: Loss of pension benefits Loss of spouse’s pension Loss of death in service benefits With a periodic payment order the ex-spouse is deemed to have received their share of the income from the member; this means the whole income is taxed at the member’s marginal rate. Earmarking has several major drawbacks: The member can retire when it suits them and therefore dictate when the ex-spouse will receive any benefit Benefits stop when the member dies. The ex-spouse could potentially get nothing at all The ex-spouse cannot define in any effective way how funds are to be allocated and into which types of investment funds. The member could potentially hold all investments in low risk, low-yielding investments A final salary scheme member could decide to reduce benefits by opting out of the scheme and then starting a new post-divorce pension arrangement There is a clear incentive to cohabitation in the automatic termination of the court order on remarriage The whole pension is treated for tax purposes as the member’s and earmarked payments are provided from the net pension received There is no clean break - something many people desire in this situation There are advantages however for the member: No money/assets change hands at the time of divorce If the ex-spouse remarries the periodic payment order lapses If the ex-spouse dies before benefits start any periodic payment stops Member has full control over timing, where funds are invested and decision to transfer Impact on lump sum allowance As the member still owns all pension rights, any earmarked lump sums are valued against their lump sum allowance The ex-spouse receives a lump sum that is not valued against their lump sum allowance What are the two types of earmarking order? Answer : Purchase course for answer All revision test s will open in a new window. |
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